CREJ - Journal

March 18-March 31, 2015 —

COLORADO REAL ESTATE JOURNAL

— Page 31

Finance

or the past two years,

we have all heard the

concerns about themas-

sive multifamily development

pipeline and the tidal wave

of new units coming on line

in Denver. It is no doubt eye-

opening to see approximate-

ly 20,000 new for-rent units

scheduled to hit the market.

What’s even more eye-opening

are the 7,071 units absorbed in

2014 accompanied by the 12

percent effective rent growth in

the midst of this huge pipeline.

This fundamental growth is a

trend that has raised headlines

and opened eyes for the past

four years and has drawn a

tremendous amount of capital

to Denver during that time.

2014 was an extremely strong

year for Denver multifamily,

but how did we get here?

What started it?

Simply

put, pent-up demand and jobs.

From 2004 to 2012, we deliv-

ered 18,817 units, or 2,091 units

per year, to the Denver metro

area. Absorption outpaced

deliveries most years during

that time period, leading to the

significant pent-up demand

from huge population growth

and in-migration. To put it into

perspective, our population

in the Denver metro area has

increased by approximately

240,000 people since 2010. Tak-

ing a conservative 10:1 ratio,

that’s 24,000 new renters to the

market in the past five years.

You also cannot ignore the job

growth story.

Denver and Colorado have

made a dramatic shift from

an oil and gas cow town to

a highly diversified economy,

where natural resources and

mining was ranked No. 6 in job

creation (7 percent) last year.

Shockingly, construction was

No. 1 (23 percent). Denver’s

main industries that led us

out of the recession and into

the hearts of investors across

the globe are aerospace, avia-

tion, bioscience, broadcasting

and telecom, energy, financial

services, health care and well-

ness, and information technol-

ogy and software. This highly

diversified new Denver has led

us to a No. 2 ranking across

the country for employment

growth (unemployment sits at

3.9 percent today) and more

than 159,000 jobs added since

2010. Taking a conservative

5:1 ratio, that’s 31,800 units of

pent-up demand directly cor-

related to jobs.

The combination of pent-up

demand from jobs and popula-

tion growth led us to well over

10,000 units of unmet demand

since 2010. Five straight years

of this unmet

d e m a n d

has directly

resulted in

54.4 percent

e f f e c t i v e

rent growth

and the his-

t o r i c a l l y

low market

vacancy of

4.1 percent.

Who fun-

ded it?

Be-

cause of these

dynamics, Denver has become

a shining star across the coun-

try and has drawn significant

liquidity to our market from a

wide variety of capital sources.

Banks captured the majority

of construction loans for the

pipeline with nonrecourse (no

repayment guaranty) options

tapping out at around 65 per-

cent loan to cost. With a repay-

ment guaranty, banks were

providing construction financ-

ing up to 75 percent of cost. For

longer-term holders, life insur-

ance companies have been pro-

viding construction-permanent

loans with loan terms of 10

to 30 years. Most of these life

company structures provided

the ability for the developer to

upsize his loan at stabilization

and allow for multiple loan

assumptions. Alternative full

capital stack and participating

loan options falling between

80 and 90 percent of cost also

have been utilized to capitalize

some of these developments,

and have been a creative way

to bridge the equity gap.

On the equity front, life

insurance companies and pen-

sion fund advisers have been

the largest source of capital for

this robust pipeline, many of

which have signed on for mul-

tiple deals in the market with

the same or different develop-

ers. Those co-invest structures

are typically between 85 and 95

percent of the total equity stack

with varying preferred returns

and waterfall promotes. Other

traditional equity investors in

the market are fund investors,

hedge funds, high-net-worth

investors, along with foreign

capital. Co-invest structures

and return thresholds also vary

for those investor types, but

are generally in line with the

life companies/pension fund

advisers with a slight uptick in

return needs. The other option

prevalent in the market is mez-

zanine and preferred equity

structures. These structures

will capitalize 85 to 95 percent

of the total capital stack or cost

in the deal and have a return

threshold of 12 to 16 percent,

which mostly accrues on devel-

opment deals given the lack

of current cash flow. This has

been a great alternative that

allows the developer to capture

the majority of the upside in a

deal.

Where we are today

and where are we going?

The market continues to per-

form extremely well despite

the 15,406 units that have

delivered since 2013. Thank-

fully, the construction delays

that have plagued our market

have helped stagger the deliv-

ery schedule, providing more

spacing and in turn helping

absorption. We are not entirely

out of the woods yet and still

have significant units to deliv-

er in 2015 and 2016. In fact,

reports show the development

pipeline continuing to flour-

ish with another 20,000 units

in various stages of planning.

However, most of those deals

will struggle to get capitalized

given construction cost increas-

es, the capital shift occurring in

the market and fundamental

real estate challenges associ-

ated with some of them.

Fundamentals driving our

market are still firing on all

cylinders and capital remains

very disciplined as they evalu-

ate new opportunities in our

market. Equity is highly selec-

tive and is focused on the best

site available, best-in-class

developers and strong funda-

mentals anchoring the deal.

Equity is also starting to evalu-

ate a longer-term hold strategy

on new deals and deals that are

approaching that stabilization

point.

On the construction loan

front, there has been a capi-

tal shift tied to new banking

regulations, exposure and con-

struction pipeline perception.

The biggest two shifts are the

availability of nonrecourse

(no repayment guaranty) and

the cost of construction loans.

Nonrecourse is still available

for borrowers with strong bal-

ance sheets, but maximum

loans-to-value have dropped

to 60 percent or below for that

structure. Spread/rates have

also increased mostly due to

the new liquidity requirements

the regulations have put on

the banks since the start of the

year.

Deals are certainly still get-

ting done and, frankly, now

would be a great time to start

construction with the likely

slowdown of deliveries past

2016.

The Denver apartment demand story and the capital funding it

Josh Simon

Managing director,

HFF, Denver

the tenants at Quebec Square.

“Lenders liked that they had

very strong national tenants,”

Tupler said.

“And although Walmart

Sam’s Club and the Home

Depot, were not included the

transaction, lenders liked that

these big-box tenants shadow

anchor the tenants included in

the purchase and drive traffic

to Quebec Square,” Tupler said.

He noted that the loan is inter-

est-only for the entire 10-year

term.

“By not amortizing the loan,

Inland received a rate that is

probably 300 to 400 basis points

lower than an amortized loan,”

Tupler said.

“They received a very low

interest rate,” he said.

Also, it is a very conservative

loan-to-value transaction.

“That is typical when REITs

get financing,” Tupler said.

“They like to be very conser-

vative. They tend to stay away

from highly leveraged loans,”

Tupler said.

The low leverage also allows

REITs to receive very good

deals, like Inland did with the

Quebec Square loan, he said.

Quebec Continued from Page 29

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